American LLC Entities: Formation and Business Law

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Business law, in large part, takes the course of business associations. Business entities operate as sole proprietorships, partnerships, corporations, and limited liability companies. Apart from these distinct forms, a business can operate as an agency if its owner engages other people to run the business on his behalf. Various business laws and Acts govern the running of business associations. This essay, therefore, seeks to discuss the law of agency, partnerships, and limited liability companies (LLCs) based on the United States business environment.

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Agency

An agency is a business relationship that results from an agreement between the business owner (a principal) and the manager (an agent). This fiduciary relationship grants an agent a legal authority to transact business on behalf of the principal.1 Agent can be individuals, partnerships, corporations, or limited liability companies. For example, X who is going for a tour abroad, but does not want to lose his customers, hires Y to manage his business. X is, therefore, the principal, and Y is the agent. Likewise, a bank hires tellers to provide manual banking services for its clients who might not prefer ATMs. The bank becomes the principal and the tellers are agents. Apart from agent and principal, the agency also involves a third party. For instance, in the illustrations above, customers are the third party.

Agreements that create agency relationships can be either expressed or implied. Express agreements are formal, either verbal or written contracts. For instance, bank hiring tellers grant them express authority to transact business on its behalf through the signing of a contract. Implied agreements on the other hand are informal mainly arising from the performance of duty. For instance, a manager has an implied authority to undertake any form of repairs that his office might need.

During business interactions, an agent must disclose the identity of a principal only if the third party is aware that he is working for the principal and have knowledge of the principal’s identity. Otherwise, an agent can partially disclose the principal’s identity if the third party knows about their business association, but has no knowledge about the principal’s identity. However, when the third party has no knowledge about the business association, then the principal’s identity remains undisclosed.

The law of agency

The law of agency governs the agent-principals relationship, agent-third party relationship, and principal-third party relationship. Under agency law, the agent has both actual authority and apparent authority. For instance, Y sells a car to Z on X’s behalf. Z later detects a fault in the car. According to agency law, Y not only had the actual authority to transact the business but also apparent authority to make sure the car is in good condition.

Agency law is enforced through restatements. Unlike Restatement, (second) of Agency, which viewed principal’s vicarious liability for an agent’s liability from a master-servant point of view, Restatement (third) of Agency takes a principal-employee point of view. Restatement second § 2 gives the master the obligation to control the physical conduct of the servant hence any liability incurred by the servant also becomes the master’s liability. Restatement third takes a more formal approach to the principal’s vicarious liability in tort. An employee is defined as an agent whose principal has the obligation to control the manner in which he performs his work (Id. § 7.07 (3) (a)). Going by this definition, Restatement Third governs principal’s vicarious tort liability in the following manner: an employer assumes liability for torts committed by an employee within his scope of duty; an employee’s act is within the scope of employment only when performing duties assigned to him or engaging in business interaction under employers control (Id. § 7.07 (1), (2)).

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Partnerships

Unlike an agency, the partnership is an association of individuals or business entities to operate as “co-owners” of the business “for-profit gains”. For example, company P merges with company Q to operate as one business entity, R. Therefore, P and Q become co-owners of company R. Partnership associations take the following forms: a general or limited partnership in which case all partners have unlimited liability for both their actions and the debts of the business, and limited liability partnership in which case partners have partial liability for business debts, but full liability for their actions (pp. 23). Partnerships are, however, very rare in the United States.

The law governing partnerships

In the current business environment, the Revised Uniform Partnerships Act (RUPA) of 1997 governs partnerships. The Act provides guidelines for the formation of the partnership, nature of the partnership, partner-partnership relationship, partner-partner relationship, and dissociation of partners. For instance, § 15-301 of RUPA (1997) describes partners as agents of business hence providing for the use of agency law. RUPA (§ 15-305 and § 15-306) transfers full liability of personal conduct as well as business debts and other liabilities to partners.

S corporation

An S corporation is a corporation that makes a legitimate election to be taxed per the Subchapter S of chapter 1 of the Internal Revenue Code. S corporation is not liable to federal income taxes. Its shareholders share the corporation’s returns or losses and report the returns or loss on their private income tax returns (single taxation). S corporation status affords various benefits of partnership taxation, besides providing owners with limited liability protection from creditors. The S corporation protocols are found in Subchapter S of Chapter 1 section 1361 through 1379 of the Internal Revenue Code.

The following criterion is used to qualify an election as an S corporation:

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  1. Must qualify as an entity, that is, either a limited liability company or domestic corporation
  2. Must possess just one class of stock
  3. Must not comprise of more than 100 or fewer shareholders. Spouses and families are regarded as single shareholders
  4. Shareholders must be citizens or residents of the United States and must be ordinary individuals excluding corporate shareholders and partners. Nevertheless, outstanding 501(c) (3) corporations, such as tax-exempt corporations, estates, and trusts, are accepted to be a shareholder.
  5. Profits and losses must be divided among shareholders according to everyone’s interest in the business.

If a corporation satisfies the foregoing qualifications and wants to be taxed per Subchapter S, its members may file Form 2553: Election by a Small Business Corporation with the Internal Revenue Services [IRS], signed by all of the shareholders. In case a shareholder is a resident in a community property state, his/her spouses must also sign Form 2553.

The agents of an S corporation must make the election by the 15th day of the 3rd month of the tax year that may affect the election or at any day within the year immediately prior to the tax year. Nevertheless, Congress has instructed the IRS to exercise leniency regarding late S elections.

Taxation issues

The S corporation election determines its treatment for federal income taxes purpose. The election does not affect the criteria for that corporation regarding other Federal taxes including FICA and Federal unemployment taxes.

The FICA tax is endorsed, like in the case with other corporations, only with regard to employees’ wages instead of proportionate shares of the members. The IRS and correspondent state revenue agencies can reclassify distributions remunerated to shareholder-employees as wages on the condition that the shareholders-employees are not remunerated a proper wage for the services they perform based on their post in the company. However, the FICA tax is not charged on proportionate shares.

Limited Liability Companies (LLCs)

A limited liability company is a business association whose characteristics reflect both aspects of partnerships and corporations. Limited Liability Company is an incorporated legal entity distinct from its members. Just like partnerships and corporations, LLCs have the characteristics of member profit taxation and limited liability respectively. Profits (dividend) are shared based on individual member interests. The members, who are its owners, have freedom of contract thus can withdraw their membership whenever they wish. Depending on the provisions of articles of organization, either member become the managers of LLC or appoint a board of managers to run the business on their behalf (pp. 118).

The law governing LLCs

Limited liability companies are relatively new legal entities, and there are few disadvantages to forming this business structure. The Uniform Limited Liability Company Act (ULLCA) governs limited liability companies. The Revised Uniform Limited Liability Company Act (RULLCA) of 2006 provides legal guidelines for the formation of LLCs, management of LLCs, member liability, and company life continuity. For instance, Mr. Smart, as the organizer, wishes to form a limited liability company, which has no members during its formation stage. Section 201 of the Act allows Mr. Smart to obtain a certificate of organization, but the company only becomes operational upon receiving at least one member and Mr. Smart has to file for a second certificate indicating that the company has confirmed membership of at least one person. Similarly, a member can seek a court order under section 701 (5) (b) to dissolve an LLC on grounds that the managers are acting in an oppressive manner that is likely to be harmful to the member. Section 106 governs the internal affairs of the LLC including liability of its members and managers for obligations, debts, and other company liabilities.

Apart from RULLCA, Agency law can also handle cases arising from the operations of LLCs. For instance, appointing a member as the manager makes him an agent of the company and the powers that bind him to the company can only be interpreted through agency law.

Advantages of LLC’s

Like owners of a corporation, LLC owners are protected from personal liability for business debts and claims- a feature known as “limited liability,” while at the same time allowing partnership-style taxation. Like owners of a corporation, LLC owners are protected from personal liability for business debts and claims (limited liability). In essence, if the business owes money or faces a lawsuit, the assets of the business are at risk but usually not the personal assets of the LLC owners. LLC owners report their share of the business profits or losses on their personal tax returns. The LLC itself is not a separate taxable entity.

LLC Formation Costs and Procedures

An available LLC name may be reserved for 60 days for a $10 fee with the Secretary of State (California). The filing fee is $70, payable to the Secretary of State (California)

California charges LLC is a minimum $800 annual tax, payable to the Franchise Tax Board.

Additional annual LLC fees to the Franchise Tax Board for annual total income exceeding $250,000.00 breaks down as follows:

  • $250,000-$499, 99: $900
  • $500,000-$999, 99: $2,500
  • $1,000,000-$4, 999, 99: $ $6,000
  • $5,000,000 or more: $11, 790

Income Taxation

For U.S. Federal income tax purposes, LLCs are treated by default as a pass-through entity. If there is only one member in the company, it is treated as a “disregarded entity” for tax purposes, and the owner reports the LLC’s income on his or her own tax return on Schedule C. For LLCs with multiple members, the LLC is treated like a partnership; therefore, it must file the IRS Form 1065. Individual partners would receive a K-1 for their share of income or losses to be reported on that owner’s tax return.

As an option, LLCs may also elect to be taxed like a corporation by filing IRS Form 8832 (see attached). They can be treated as a regular C corporation (taxation of the entity’s income prior to any dividends or distributions to the members and then taxation of the dividends or distributions once received as income by the members), or an LLC can elect to be treated as an S corporation. Some commentators have recommended an LLC taxed as an S-corporation as the best possible small business structure. It combines the simplicity and flexibility of an LLC with the tax benefits of an S-corporation (self-employment tax savings).

International Business Law: California LLC’s

Resolving disputes between individuals who are citizens of different countries, with business deals that span continents and cultures alike can be beset with uncertainty. However, as a California LLC, any litigation would likely fall under the jurisdiction of the California State Court as a “civil action wherein jurisdiction is founded on diversity of citizenship may except as otherwise be provided by law, be brought only in the judicial district where all plaintiffs or all defendants reside, or in which the claim arose.

Further, to register as a foreign owner of LLC in California, a person or group must contact the Secretary of State’s office in California. The Secretary of State will determine if registering, as a foreign LLC is required based on a foreigner’s status. In spite of variations in requirements, the foreigner must meet the following criteria:

  • She/he must own a bank account in California;
  • The person must sell goods or services in California or advertise to residents of the state;
  • S/he must sustain a retail store, a distribution facility, factory, or an office in the state;
  • At least one of His/her/their LLC asset, both real and personal asset, must reside in California;
  • She/he must be a regular visitor of the state on business deals, including meetings.

Characteristically, the Secretary of State’s website will provide information for foreign LLC registration. A form known as a Certificate of Authority or Application for Authorization will be necessary for registration of LLC. The foreigner will be required to complete the form and send it via mail to the relevant office accompanied with any important information. There is no extra filling or follow-up required.

Conclusion

Business law plays a critical role in providing a legal framework for the smooth running of any commercial endeavor. Depending on the type of business entity we choose to form, it is mandatory that we come to a meeting of the minds and are informed of the various laws governing the business to avoid inconveniences resulting from unfamiliarity. An agent is designated to look out for the principal’s welfare in the capacity to which the agreement has been formed. This relationship exists in all cooperative efforts such as in corporate forms and governmental authorities and bureaus.

References

Fiduciary Obligation, Agency, and Partnership. Deborah A. DeMott. West Publishing Co. American Caseebook Series, (1991)

Form Your Own Limited Liability Company, Nolo, 6th Edition, Attorney Anthony Manusco,September 2009, Nolo Publishing

Keatinge et al., “The Limited Liability Company: A Study of the Emerging Entity,” 47 Business Lawyer 375, 383-384 (1992) (citing Act of March 4, 1977, ch. 155, 1977 Wyo.Sess.Laws 512).

165 Ill.App. 3d. 783, 117 Ill.dec. 406, 520 N.E.2d. 757

26 U.S.C. § 1361(b) (1) (A)

Recent Reform and Simplifications for S Corporations

26 U.S.C. § 1361(c) (6)

Form 2553. Election by a small business corporation. Section 1362 of the internal Revenue Code. OMB No. 1545-0146. Rev. 12-2007. Web.

Department of the Treasury International Revenue Service. Instructions for Form 2553. Rev. Web.

Liability Limited Companies Company [LLCC]. How to Register a Foreign LLC. LLC Company, 2011.

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DemoEssays. "American LLC Entities: Formation and Business Law." March 13, 2022. https://demoessays.com/american-llc-entities-formation-and-business-law/.